Californians may have to pay tax on canceled mortgage debt

Central Valley real estate agent Donny Piwowarski last year sold his four-bedroom, 3,500-square-foot house on a half-acre in Tracy for $387,000 — about half of what he paid for it in 2005. Now with tax-filing season here, his situation is getting even grimmer.

Under California tax law, Piwowarski owes tens of thousands of dollars in state income tax on the nearly $400,000 in mortgage debt that was “canceled” when he sold his house for less than what he owed. The state considers canceled debt as taxable income in cases like Piwowarski’s and for thousands of other Californians who got rid of their homes last year in so-called “short sales.”

Since 2007, federal law has seen things differently, in many cases sparing sellers any tax on debt canceled in a short sale, foreclosure or loan modification. In 2007 and 2008, California followed the feds’ lead, but the state law has not been extended to apply to mortgage debts canceled in 2009.

So an estimated 35,000 California taxpayers may be left owing state tax for 2009 on something the federal government does not consider taxable, according to the state Franchise Tax Board.